Papua New Guinea and the challenges of LNG

Papua New Guinea and the challenges of LNG

Flavio C.C. Munoz
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The decline in oil prices in the global market has led Papua New Guinea (PNG) to revise downward the revenues expected from the construction of its LNG facility. The joint venture partners involved with the project will likewise confront reduced revenue, though the low cost of production means that they can still make a profit, even in an era of low oil prices. Furthermore, PNG LNG is regarded by participants and international experts as one of the most competitive greenfield LNG projects in the world

The decline in oil prices in the global market has led Papua New Guinea (PNG) to revise downward the revenues expected from the construction of its LNG facility. The joint venture partners involved with the project will likewise confront reduced revenue, though the low cost of production means that they can still make a profit, even in an era of low oil prices. Furthermore, PNG LNG is regarded by participants and international experts as one of the most competitive greenfield LNG projects in the world.

Substantial funding but the project is competitive

PNG’s LNG plant, designed to produced 6.9 million tons of gas per year, is a vertically integrated development compromised of upstream production systems, processing and treatment facilities, pipelines and a liquefaction plant. At the time of project sanction, the total project cost was estimate at approximately $18 billion. The project debt was raised by loan commitments of $14 billion with six Export Credit Agencies (ECAs), 17 commercial banks and other co-financiers. The equity sponsors are affiliates of ''ExxonMobil (33.2 percent), Australian‐based firms Oil Search Ltd. (29 percent) and Santos Ltd. (13.5 percent) Japan Papua New Guinea Petroleum Co. and Nippon Oil Exploration Ltd. (4.7 percent). The three state‐controlled Papua New Guinea firms (totaling 19.6 percent) are Mineral Resources Development Co. Ltd., Petromin PNG Holdings Ltd. and The Independent Public Business Corp. of Papua New Guinea''. The project’s competitive advantage results from the fact that the plant produces large amounts of gas (9.2 trillion cubic feet [tcf] 2P) with high heating value, minimal impurities and high quality liquid content, which makes it well suited to the Asian market, whose gas demand is expected to double to 400 million tons per annum (mtpa) from 2015 to 2035 (70 percent of the global demand).

PNG's LNG plant, designed to produced 6.9 million tons of gas per year, is a vertically integrated development compromised of upstream production systems, processing and treatment facilities, pipelines and a liquefaction plant

The plant's effects on profitability

Global oil prices have brought a decrease in oil-indexed gas and LNG contract prices

The idea for the project derives from the belief that Asian demand for LNG is expected to grow at a high rate, that the price of Asian LNG would remain high and, therefore, so would return on investment, and that production is expected to be able to turn towards possible secondary markets such as Europe. However, world oil prices are lower than ever, which has in parallel brought oil-indexed gas and LNG contract prices. Papua New Guinea supply contracts entered into with four Asian buyers are linked to swings in oil prices, meaning returns on investment are more susceptible to volatility in the markets than those from exporting facilities in the U.S. However, these contracts are take-or-pay, meaning that the buyers must pay for natural gas supply whether they need it or not. In the case of the project in PNG, the oil and gas value generated is estimated between $55 billion and $123 billion. However, one of the project financiers, Oil Search, has seen its total revenue decrease by 39 percent from $562.1 million to $342.9 million in just one year as a consequence of the sharp drop in oil and gas prices. According to Fereidum Fesharaki, chairman of Facts Global Energy, once Iran increases production following the removal of international sanctions, oil prices could fall further to $25 per barrel. But, Oil Search is optimistic and says that based on its current cost structure it would still generate positive operating cash flow even if oil prices fell to $20 per barrel.

The effect is that there will be no taxable profits for the LNG project for many years, until oil prices increase, but dividends to shareholders will be less affected as they are paid directly from cash flows

New options for market expansion

The Port Moresby government calculates its budget on an ''implied profit rate of 26 percent in 2015 and 28 percent in 2016''. These seemed like healthy profit ratios, but they will disappear with the 30 percent fall in gross revenues due to current oil prices. The effect is that there will be no taxable profits for the LNG project for many years, until oil prices increase, but dividends to shareholders will be less affected as they are paid directly from cash flows. 155 LNG cargoes have already left the plant since production commenced in April of 2014, while production capacity has increased from 6.9 mtpa to 7.6 mtpa. Despite this, the future profitability of the plant remains uncertain. Papua New Guinea will need to review its policy to deal with the declining profitability, while the project financiers look to pursue new expansion options by adding a third gas liquefaction train in order to maximize production from the existing trains and generate a 17 percent increase in annual return (Citi forecasts).